For more than two years I've written off MGM Resorts (MGM +0.70%) as a scrap in the gaming business. Growth in Asia made Las Vegas Sands (LVS +1.48%), Wynn Resorts (WYNN +1.31%), and Melco Crown (MPEL +1.46%) far more attractive, and their share performance has justified that stance so far.
But as Macau slows and the U.S., and more specifically Las Vegas, appears to be headed toward growth, it's worth taking another look at this stock. Last week's debt offering, lowering interest costs in the process, also makes MGM intriguing.
The balance sheet
The big worry for MGM over the last few years has been the balance sheet. MGM has $13.8 billion of long-term debt as of the end of the third quarter, and that debt has been growing to support weak results in Las Vegas. But Las Vegas is on the mend and MGM is aggressively improving its balance sheet.
Just last week the company began refinancing $4 billion of debt and sold another $1.25 billion in debt that will be used to pay off upcoming debt maturities. If the offer made to creditors is accepted, MGM will lower interest expenses that totaled $275.8 million last quarter. With the new debt, the company will also have enough cash to pay for debt maturing into 2015.
What needs to happen for the balance sheet to really make a turnaround is a stronger recovery in Las Vegas.
Don't call it a comeback
Las Vegas was hit harder than most areas during the recession, but we're seeing a slow and steady comeback. Over the past 12 months, gaming revenue has grown 3.2%, not an earth-shattering pace, but improvement nonetheless.
What hasn't improved recently is non-gaming revenue. Rooms, food and beverage, and entertainment revenue all fell in the most recent quarter, a sign that consumers aren't spending yet. The next few months for the economy, especially the fiscal cliff negotiations, may tell whether non-gaming revenue will start to grow again or continue to decline. I think we're in for a strong economy over the next few years, driven by housing and consumer confidence, and that should push revenue higher in Las Vegas.
Sprinkle in some Macau
I've focused on Las Vegas so far, but the crown jewel in MGM's portfolio is its 51% stake in its Macau subsidiary. Adjusted EBITDA at MGM China was $152.5 million last quarter, more than the Bellagio, MGM Grand, and Mandalay Bay combined.
This subsidiary will continue to spit off profits, but the big reward will come when MGM completes its expansion on Cotai. MGM is in the process of getting a resort approved on Cotai that has a location sandwiched between Melco Crown's City of Dreams, Las Vegas Sands' Cotai Central, and Wynn Cotai. The resort will be a game-changer for the company.
Valuation
With gaming companies, the final question always comes down to value. I've laid out the case that MGM could pay for its debt and grow revenue and profits into the future, but what are investors paying for this company?
Right now, MGM has an enterprise value/EBITDA of 10.1, lower than Las Vegas Sands' 11.1 and Melco Crown's 10.3. Wynn is lower at 8.8, which is why this is my top gaming stock right now, and Caesars (CZR +0.00%) trades with a 9.8 multiple, but Caesars has $20 billion in debt and no exposure to Macau, so the multiple isn't nearly as attractive.
The reason I think MGM's valuation may be reasonable for investors is the leverage the stock provides. $11.6 billion of net debt versus a market cap of $5.3 billion means that a 20% increase in enterprise value leads to a 64% increase in the stock price. Compare that to the same enterprise value increase at Melco, which has little debt, and the stock would only go up 22.4%. Of course, this also puts leverage on the downside as well, so with potential reward comes risk.
Foolish bottom line
The debt refinancing last week has made me take a second look at MGM, and the stock isn't quite the dog it once was. I still think Wynn is a safer bet in gaming, but if the U.S. economy improves, the gains for MGM could be substantial. I'm not ready to buy shares personally until I'm sure the economy isn't headed to a recession again, but I'll add an outperform call on CAPS to track the stock, because I think it will beat the market over the next five years.
